Abstract

This study analyzes collusion in an enterprize
in which concerns about hedging cannot be ignored. In our two-agent
single-task hidden-action model, where all parties involved have
exponential utility functions and the principal owning normally
distributed observable and verifiable returns is restricted to offer
linear contracts, agents are assumed to be able to exploit all
feasible collusion opportunities via enforceable side contracts.
Hence in general, an optimal incentive compatible and individually
rational contract is not necessarily immune to collusion. We
characterize situations in which concerns about collusion may or may
not be ignored. Restrictions due to collusion are analyzed and we
prove that collusion may be ignored when arranging the agents to
work with the ``highest effort profile'' is optimal for the
principal with the usual constraints, and the two moments of the
return are monotone separately in effort levels of both of the
agents. To show that these assumptions are minimal, we construct
examples for situations in which any of these assumptions are
violated, proving that collusion makes the principal strictly worse
off.